Your Adjustable Rate Mortgage Probably Needs To Be Refinanced!

For those of you who’ve wisely taken out adjustable rate mortgages (ARMs) over the past 10+ years, pat yourself on the back. You’ve saved plenty of money by paying a much lower interest than if you took out a 30-year fixed mortgage. Getting a 30-year fixed mortgage has not been a financially optimal choice because most people sell after 7 years and the 10-year bond yield has been going down for the past 30+ years.

Even with the Fed finally raising the Fed Funds rate in December 2015, mortgage rates for NEW mortgages have declined by about 0.5% because the Fed doesn’t directly control mortgage or consumer lending interest rates. The market does. And right now, investors are piling into Treasuries due to fears of a global recession.

For anybody with an ARM mortgage, you need to read this post and refinance before your interest rate adjusts. Before December 2015, the Fed hadn’t raised rates since 2004 (see pic). As a result, most ARM holders blissfully saw their interest rates adjust flat to lower once the fixed period was over. Not any more!

REFINANCE YOUR ARM TODAY

I watch interest rates every day because the 10-year bond is in my portfolio. The stock market volatility of 2016 has seen Treasury bond prices surge as investors seek safety and liquidity. The 10-year yield collapsed to near all-time lows in 1H2016, but is marching higher as we enter 2017.

Japanese Government Bond yields now have negative real interest rates (same with Australia and Sweden), which means deflation might be back. From an economist’s point of view, nothing is more evil than seeing prices go down and having everyone believe prices will continue to go down. Consumption and investment grinds to a halt, and the economy gets stuck in a death spiral.

Government bond yields back down to record lows in 2016

Adjustable rate mortgages and 30-year fixed mortgages closely track the 10-year government bond yield. Back in January 2015, I was able to successfully lock in a 2.25% 5/1 ARM jumbo loan with Chase. Unfortunately, they rejected me two months later due to the inability to recognize my freelance income.

So far, after checking online with LendingTree, and checking offline with Citibank and Chase, the best 5/1 ARM jumbo loan I can get is 2.375% and zero points. That’s still pretty damn good, since my current 5/1 ARM is at 2.625% and expires in mid 2017. That said, it’s still not the same as the 2.25% I got in January 2015 even though the 10-year yield is at the same level.

The likely reason? Lower margins. It seems banks are no longer accepting as small a profit margin as they were back in 2015 because banks are today more cautious about our future economic well-being. Makes sense. Over the past couple years, bank stocks have gotten hammered. Further, I think most of us are far less bullish than we were a year ago.

When I asked my banker for details about my current 2.625% 5/1 ARM loan, she responded with the following information:

First Adjustment: 6/1/2017
Margin: 2.25%
Index: LIBOR (index as of this week: 1.14%)

When I asked her to confirm whether this meant my mortgage interest rate would be equal to Margin + Index = 3.39% if the first adjustment was today, she said YES. I spoke to the loan officer for 45 minutes to clarify all information to help provide the best information possible for this post.

Going from 2.625% to 3.39% is a whopping 29% increase! This means a $1,000,000 mortgage monthly payment would rise from $4,017 to $4,429 according to LendingTree’s mortgage calculator. On the flip side, if I refinance down to 2.375%, payment would go down to $3,887 a month from $4,017. Saving $130 a month is nice, but the real benefit is saving myself from having to pay 3.39% and $542 a month extra after 6/1/2017!

UNDERSTAND YOUR MORTGAGE INDEX

For those who don’t know, LIBOR is the average interbank interest rate at which a selection of banks on the London money market exchange are prepared to lend to one another. LIBOR comes in 7 maturities (from overnight to 12 months) and in five different currencies.

The LIBOR interest rate is used as a base rate by banks and other financial institutions. Rises and falls in the LIBOR interest rates can therefore impact interest rates for savings accounts, mortgages and loans. However, notice how your money market savings account still hasn’t really risen as much. That’s because banks want to keep their costs low and realize they don’t need to entice new deposits because everybody is fleeing risky assets.

It is common to assume that so long as the 10-year yield would remain low, any adjustment in an ARM would simply adjust at the same rate or lower. After all, everything is interrelated in finance. The reality is, the interest rate adjustment all depends on what your ARM is indexed to. Most ARMs are indexed to LIBOR.

LIBOR moves very closely with the Fed Funds rate because both rates are SHORT TERM rates. See how LIBOR jumped by roughly 1% since July 2015 after the Fed raised the Fed Funds rate by only 0.25% in December 2015. That is a crazy jump!

The logical assumption is that LIBOR will now probably decline as the Fed isn’t raising rates as aggressively after such a volatile year and uncertainty with the election. At the beginning of 2016, the market believed the Fed would raise rates by 4 times. Now, a second rate hike is unlikely. LIBOR should stop rising so much, but it hasn’t.

If your ARM so happens to adjust during this LIBOR spike, then you’re unlucky because adjustments often lock for the next 12 month period.

ACTION ITEMS FOR ARM HOLDERS:

1) Find out what your mortgage interest rate’s margin and index. The most likely answer is that your ARM is indexed to the 12 Month LIBOR rate. If your ARM were to adjust today, the new rate will equal the margin + index.

2) Once the mortgage interest rate adjusts, ask how often will the interest rate, and therefore your payment adjust. Some ARMs after their initial fixed period might adjust monthly according to the LIBOR rate. Most ARMs will adjust once a year. The worst is to have your ARM adjust during a temporary spike up in LIBOR as we are seeing now and lock the higher rate for 12 months.

3) Ask what is the mortgage interest rate maximum lifetime cap is. Given your mortgage’s margin is fixed, the lifetime cap is really a protection on the index going too high. For example, my ARM’s lifetime cap is 5%.

4) Find out the current refinance rates for a 3/1 ARM, 5/1 ARM, 7/1 ARM, 10/1 ARM, 15-year fixed, and 30-year fixed and what your corresponding payments will be. I’ve found the 5/1 ARM to have the best mix of interest rate and duration security. You can do a lot to pay down your mortgage or improve your wealth in a five year time frame. I’m still not a fan of 30 year fixed mortgages because the interest rate is usually 1-1.5% higher than a 5/1 ARM. I hope everyone realizes by now that interest rates will stay low for a long time.

5) If you do refinance, clarify with the loan officer whether you are resetting the amortization schedule (start back to year 0 out of a 30 year amortization period) or keeping it the way it is (e.g. paid mortgage for 5 years, and will have 25 years left until the entire mortgage is paid in the new loan). It’s generally a good idea to keep your amortization schedule as everyone should try and pay off their mortgage before retirement.

6) Take the cost of the refinance and divide it by your monthly interest savings. At the minimum, the break even period has to be less than the duration you plan to hold the property. The sooner the break even period the better. As a general rule, my recommendation is for two years or less and/or an interest rate differential of at least 0.375%.

SAVE MONEY DURING A CORRECTION

Rates are finally rising in 4Q2018 – 2019. So thankful I refinanced!

Refinancing your mortgage is the one beautiful thing everybody should do in an economic downturn. You certainly want to do this before you potentially lose your job! Once you lose your W2 income, you are dead to banks. I absolutely will be trying to refinance again now that the 10-year yield is back down, and my financials are stronger due to two years worth of consulting income and less debt.

I strongly believe most ARM holders DO NOT realize that once their ARM adjusts, the interest rate will be much higher than their existing rate due to a ramp in LIBOR. Do not be under the assumption that because the 10-year bond yield is collapsing, your ARM mortgage interest rate will cooperate.

To get the best mortgage rate, you must make banks compete against each other with written offers. The easiest way to get a whole bunch of offers is to apply for a no-commitment quote online. Either go with the best quote or use the information to get your existing bank to match or beat. This is exactly what I’m doing, and exactly what my Citi loan officer has requested from me. Banks do not want to lose your business.

Recommendations

Refinance Your Mortgage: Check out LendingTree for some of the lowest free mortgage rate quotes online for purchase or refinance. They’ve got one of the largest banking networks today. Rates have come down post election, and even after the Fed started hiking interest rates. When banks compete, you win.

Explore real estate crowdsourcing opportunities: If you don’t have the downpayment to buy a property, don’t want to deal with the hassle of managing real estate, or don’t want to tie up your liquidity in physical real estate, take a look at Fundrise, one of the largest real estate crowdsourcing companies today.

Real estate is a key component of a diversified portfolio. Real estate crowdsourcing allows you to be more flexible in your real estate investments by investing beyond just where you live for the best returns possible. For example, cap rates are around 3% in San Francisco and New York City, but over 10% in the Midwest if you’re looking for strictly investing income returns.

Sign up and take a look at all the residential and commercial investment opportunities around the country Fundrise has to offer. It’s free to look.

Less than 5% of the real estate deals shown gets through the Fundrise funnel

Author Bio: Sam started Financial Samurai in 2009 to help people achieve financial freedom sooner, rather than later. He spent 13 years working in investment banking, earned his MBA from UC Berkeley, and retired at age 34 in San Francisco.

Sam’s favorite free financial tool he’s been using since 2012 to manage his net worth is Personal Capital. Every quarter, Sam runs his investments through their free Retirement Planner and Investment Checkup tool to make sure he stays financially free, forever. It’s free and easy to use.

For investing opportunities in 2019, Sam is most interested in investing in the heartland of America through real estate crowdfunding. Property valuations are much cheaper and net rental yields are much higher. There is a demographic trend towards moving away from higher cost areas of the country to lower cost areas thanks to technology.

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Comments

Wow this is so thorough and very timely! Really good to know about how all this works. We haven’t really had to worry about floating rates for a while but things have changed with rates going back up. Thanks!

Man, do I love this website! I almost always learn something new, and very useful. I am considering my first refi now from 30 yr. fixed (as I have always done) to ARM. I think it makes sense in this rate environment.

FYI, we live in the same neighborhood. Glad to see you love your new(ish) home so much. It is a great place to live.

Ditto what John Cranshaw said about loving this website and always learning something new!

Many, many years ago when I bought my condo, I didn’t realize that the initial rate they gave me on my ARM was less than what the current index + margin was, so I assumed if the rate were to unlock that day, my payment would remain the same. This was before a lot of the Truth in Lending Act disclosures that are now required after the 2007-08 crash (now they have to tell you clearly what the discount rate is). Fortunately, I got lucky as all get-out because the rates dropped and my mortgage payment actually ended up going down significantly!

“Doesn’t being able to save money on a mortgage make you love real estate more than stocks?” YESSSSSS. This is one of a handful of reasons why I will always be a bigger fan of real estate investing than stock market investing.

I’ll stick with my 20 year fixed and keep paying it off early, especially since I’ve been living there 10 years already.

Being the sole breadwinner for a growing family in an uncertain economy, knowing I’ll be paid off shorter than the usual 30 years, but can reduce payments if I need to, and never have to worry about the rate going up, reduces my worries.

Most people optimize purely for ROI. Some might call me risk averse, but I’m actually stress averse. Life is full of stress and worry. Paying more to maintain a low stress level is worth the cost to me, personally. Refinancing every few years, payments changing regularly, is just more trouble than I’m willing to spend now.

I’m with you. I’ve a 30 year mortgage, which I am paying off as I can, though I took Sam’s advice on an earlier post and am careful that I don’t put too much to it (due to economic uncertainties). Stress is a killer, and one I try to avoid. Life/work are stressful enough.

I have always felt that ARMs are a bad product that’s suitable only for speculators. Why would one take resetting risk? Rates may go up, one can lose his W-2, as you wrote, or other events that may make one less creditworthy in the eyes of the lenders may occur.

I feel that a fixed rate is the easiest option and if one really wants to save on the interest, then perhaps prepaying the loan would achieve better results that carrying an ARM until the next reset period with the hope that rates go down.

If you believe interest rates will finally rise after 35+ years of decline, and if you plan to own your home forever, then getting a 30-year fixed is not a bad idea. I just hope nobody actually TAKES 30 years to pay off that higher interest rate mortgage.

I would actually sleep LESS well every time I have to pay a mortgage payment because it would bother me that I would be paying more interest than I need to. I DON’T want banks to earn more money from me than they should.

You stil have to make monthly payments with an ARM. I suggested to get a fixed rate, prepay as much as possible every month and sleep at night not having to worry about the next reset date. I did not write to carry a fixed rate for 30 or more years.

Besides, I always seen the extra interest paid to the banks as the price of serenity, a sort of insurance against refinancing risk, if you wish.

For people like myself, the peace of having a fixed rate and not having to worry at all about a rate hike is what I prefer. For an investor or people who are able to be active with shopping for rates the ARM can be best, you have to stay actively involved.

I actaully went from a 5/1 ARM to a fixed 15 year rate in Central California about 2.5 years ago. I had 2.50%, but didn’t finish the paperwork to lock and ended up with 2.625%. Now I am hesitant to look at a new house because I don’t want to lose my great 15 year rate! I love seeing the principal decrease significantly faster than it used to.

Well more good news for the LTV sucks crowd without a fannie mae or freddie mac. Are they out of business yet? All those ING ARMs are. Refi anytime for a flat fee? Remember? Now they are held by CapOne who just shed the 360. Yes its THAT CapOne of credit card fame.

So if you had a 7/1 which you could not refi….can you spell underwater? Guess what? You STILL can’t. Look at what the rate cap and spreads are on these puppies. Hey the credit cards were UNsecured loans…these carry plenty of security and curbside appeal. YOUR ass on the curbside.

We wrote this back in the day..(in July 2009 possessing a good LTV we did a flat fee modification and took some cash out)..What point will the LIBOR be at in six months at reset? I am paying close to 5. Oh thats better than the Jimmy Carter 14 it was when I was only dreaming of owning a home. Rich Dad can you hear me?

We agreed an ARM was a better deal but for the strangest reason. We knew it was a 30 year term but we were seduced by the notion of saving all that interest to paydown principle. Oh BTW the cash out refi reset the mortgage interest to principal ratio, so we are still paying the early years ratio, you know the drill principal blah blah interest blah blah blah blan blah blah..like the adults in a Charlie Brown Christmas.

Well why don’t you do a cash paydown from stock holdings, they allow you to do that, your getting killed there anyway. Why don’t you just walk? Well its a senior community. It quiet. For New Jersey its like the Cayman friggin Islands of property taxes and I am 29 mins to my workplace. I considered myself pretty smart moving here after losing one house to divorce downsizing before it was totally necessary. All MY cougars are 80, but I have my choice of fresh baked pies. I also came here for the old saw, hey you want to feel young hang out with old people.

Oh as we move into a full blown recession housing prices will go up, right? I will be able to refi like you suggest, right…..rrrrrright?

I have a 3% 15 year fixed on a remaining 310,000 mtg. I received a rundown from lending tree and the best 5/1arm they quoted me was a 2.375% with an apr of 3.23%. Looks like rates need to drop alot further for me to benefit??

How do you get access to these low rates in the 2% area. I am currently in a 5/1 ARM at 3.125%. I checked Lending Tree yesterday and the best I got back was 3%. I have an 800 credit score and well over 20% equity. Any tips?

I not only search online, but I call my relationships at Citibank and Chase. I’ve got 3 quotes at least and pit them against each other like a bullfight. As a result, I was able to easily knock off 1/8th of a point from the lowest quote.

3.125% is HIGH for a 5/1 ARM right now. Don’t do it. They might be checking your credit score or existing relationship or assets. What are they?

After reading one of your earlier posts from a year or so I go, I bit the bullet and refinanced to a 5 year ARM at 2.75%. I was glad I did. The closing costs were waived provided I didn’t refinance in 3 years. This was about a year ago. I’ve been toying with seeing if refinancing again would help me in any way. On the one hand, I would have to pay about $3,500 in closing costs that were waived. On the other hand, I would be ensuring another year at this rate – presuming I would get about the same (or even a lower rate). I may just wait it out.

Great job saving money and not paying more interest than you have to. I would wait it out at 2.75% and check back in two years.

I’m pretty sure LIBOR, which has been manipulated before will go back down with the 10-year crashing. LIBOR shooting up 0.5% when the Fed raised rates by 0.25% made no sense. The LIBOR banks thought the Fed would raise rates again soon I guess.

LIBOR adjusts once a week for the index for mortgages, and I’ll happily bet anyone the next move for LIBOR is DOWN.

What do you suggest I do right now. I just refinanced in Dec 2015 from a 30 year @ 5.375% to a 7/1 ARM @ 3.25. Me and my wife are in our late 40’s with college for 2 daughters in the next few years. Thanks

I suggest you stay put and enjoy your 7/1 ARM at 3.25%! It’s not worth refinancing again just two months later due to the cost and time. You have 6 years 10 months left on a 7/1 ARM that is saving you a whopping 2.125% a month interest. That is a HOME RUN.

Yes, you might be able to get a 5/1 ARM for 2.375%, but you have to calculate the costs.

Saving money is all about saving at the margin. You’ve already done a great job.

The Bay Area house I bought was a typical ARM-induced foreclosure from the subprime era. The poor guy bought for $785k but then it reset and he couldn’t afford the payments. I got it from bank for $435k in 2011. At the time, I didn’t know any better and opted for a 30 year fixed with PMI.

I refinanced to a 2.875% 15 year fixed in 2012 and threw in enough to get rid of the PMI. Throwing in considerable extra principal to get out early. About $260k left and it’s appreciated past the previous bubble highs. Not sure how long that will last? It’s tempting to cash out and live mortgage free in Oregon or somewhere like that.

Maybe it’s just me, but I was always under the impression that the ARM game was for suckers and/or people willing to risk and research enough to “beat the house.” I guess I’m just too risk averse for this game.

I don’t think back in 2011, the resetting of the ARM rate was the problem. Look at the featured image in this post. 2011 was the beginning of a downward slide in the Fed Funds rate and LIBOR.

It was the person’s financial standing that caused him to foreclose instead.

I have an economist background and am an investor who never wants to pay more than I have to. Interest rates are not going up over the long term. We are just in this funky scenario where LIBOR has temporarily ramped due to the Fed. I believe LIBOR will adjust downward by 0.25%.

He may have / likely had a balloon ARM that was initiated in 2006 or 2007 that reset in 2011. There were a lot of those and a lot more than were negative amortization for a number of years and then the last 25 years were fully amortized and monthly payments went up 3-5x overnight.

Great to hear Mike. I felt this post will be a huge epiphany to the large majority of ARM holders. We’ve been kind of lulled into “always winning” with a decline in rates. But seeing the LIBOR jump so much and understanding the index should be a huge eye-opener for people to refinance or take a good look at what their mortgage will be after an adjustment.

Jerry redux here. All I meant to say is that a refi is still out of reach because some of us are “locked in” forever because the Loan to Value ratio does not allow for a refi because we are underwater and the mortgage is not owned by Fannie or Freddie so no HARP. I can handle the payment, I could handle a higher payment. I would love to make a lower payment and kill this before I die is all.

Ah, gotcha! Yes, it has been VERY frustrating for many people since the housing crisis due to the inability to refinance, which would ironically HELP a lot more people keep their homes and not foreclose due to lower payments. The government did force banks such as Bank of America to allow more people to get a lower rate as part of their $12B penalty or so. I know b/c I got a free loan modification completely out of the blue for my Squaw Valley Vacation Property that lowered the 30-year fixed rate from 5.85% down to 4.25%.

I would LOVE to refinance that mortgage down to 3.5% for a 30-year right now, or 2.75% for a 5/1 (higher due to being a second home/rental). But, banks are still not refinancing condotel mortgages. At least citibank isn’t. I should continue to look elsewhere.

I recently went through a refinance 5/1 ARM last October at 2.625% I could’ve gotten 2.5% but the closing cost would’ve been too expensive.

I completely agree with when rates unlock after 5 years that most people don’t realize that it’ll go up even though ARM rates are low. One thing I’ll note: usually 5/1 ARM have a cap of how much it goes up per year (if your ARM adjusts per year). During closing, the loan officer pointed it out. I plan to refinance before that happened.

Didn’t know about that you don’t need to reset the loan’s amortization schedule when you refinance with the same company. That’s definitely something I’ll ask when I’ll refinance in 3 years or so.

Depending on where the ARM holder is in the Fed Funds and LIBOR cycle, yes, it is now pretty evident that your interest rate will go up. But, for the most part, the adjustment has been flat to down due to the Fed’s interest rate policies. You just don’t want to have your ARM adjust in the middle of an upswing. As a result, ARM holders should be proactive to simply refinance back into another ARM with a lower rate.

Sam, love your blog. What do you think about this? Bought $399,900 house in 2007 (0 down 5/1 arm). Initial rate was 5.65 on arm. Got divorced in 2013. At that time ARM was something like 3%. Kept house but had to refinance in my name only. Refinanced about $360,000 to 20 yr fixed at 4.25. That is where I am now.

Current payoff on mortgage is $346,000. Strongly considering refinancing into 15 yr at 3.125%. Closing costs about $6k. My payment will go up by about $150 per month, but I will take about 3 yrs off my mortgage. I plan to stay in the house for awhile due to schools and kids friends in the neighborhood (they are 1st and 4th grade).

Given these facts, curious if you and the smart commenters on this board would recommend the refi to 15 yrs at 3.125 fixed from 18.5 yrs remaining at 4.25 fixed (but would have to pay $6k closing costs).

Hi Brian – This post was particularly interesting to me, as we just refinanced our 30 FRM down from 3.875 to 3.5. We plan to stay in this home for at least 18-20 years, so for me the decision came down to not wanting to go through the refinancing process again. It’s hard for me to believe that the 3.5 rate won’t come out a winner vs ARMs over that time period. Thoughts?

Your point #6 is crucial and often misunderstood: “Take the cost of the refinance and divide it by your monthly interest savings. At the minimum, the break even period has to be less than the duration you plan to hold the property.”

The monthly INTEREST savings is what matters, not the monthly PAYMENT savings. Your monthly payment may even go up if you shorten your amortization, but that doesn’t mean that refinancing isn’t a good idea and won’t save you a lot of expense over the life of the loan (interest is the portion of the payment that is a true expense).

Yes, folks have to realize at a lower interest rate, the principal portion of the mortgage payment will decline, but so will the interest portion as well. Zero in on the interest savings, and THEN the cash flow savings.

I really got a lot out of your explanations in this article. I recently re-financed from a supposedly 30 year fully amortized loan with Capital One mostly because they couldn’t seem to apply the amortization shedule correctly to my loan with them. I finally got tired of dealing with their Office of the President as a test case and took my business elsewhere.

You are sure right, thanks to Barney/Frank, non W-2 wage earners are deemed to not be reliable payors so most people are hit by this concept when they retire despite a 30 or 40 year spotless payment record. Your payment record now no longer helps you but it sure can hurt you. I ended up re-financing with Guaranteed Rate after i approaced Chase after a 30+ year perfect payment record with them. They had no interest in a loan with me. Interestingly, 1 month later they bot the loan from Guaranteed Rate and i am not continuing my perfect payment record with them.

Although its a 30 year fully amortized rate i was able to derease my rate by 200 basis points for the next 5 years and i’ve put myself on a 7 year payment schedule so for the first 5 years, while the interest rates are the lowest and my balance is the highest i’m paying it down. If the interest rate resets back to where i was before my remaining balance will be much much lower and i’ll payoff the remaining balance in the last 2 years at the rate i had before. The entire loan w/ be paidoff in 7 years so for me a 5/7 ARM is perfect.

Again, thanks for your information about the index and LIBOR rates. Much appreciated.

Those rates sound amazing! In Australia the current rates for short term (1-3 year) fixed are about 4 to 4.5% where as 10 year (the longest I have seen in AU) is 6.5 to 7.5%.
I don’t actually know anyone who has a fixed rate loan more than 3 years however. We went variable the whole way – worked well for us, but that was just lucky timing.

I think a lot of people in America do you not realize that a lot of other people in the world do not have a 30 year fixed rates, instead it is more common to take out one year, three-year, five-year, ten year loans maximum.

I hope more Americans can see more perspective by traveling the world and understanding different economic systems. Barling at a 30 year fixed rate has really been a waste of money all these decades so far and will continue to be a waste of money for at least another Borrowing at a 30 year fixed rate has really been a waste of money all these decades so far and will continue to be a waste of money for a least another decade IMO

The last few years have been very interesting reading more about other countries (mostly US) finance. Many of the basics are the same, but certain areas are quite different.
Retirement saving (401k, IRA, or Superannuation in Australia) and Tax are the biggest differences. e.g. I would love to be able to claim interest on owner home loans but currently both sides of government are even talking about taking away the ability to claim on investment properties. We will see if that actually provides the price decrease they are hoping for.

Fantastic article, Sam! Goes to show that a 30 year fixed isn’t always better than the “crapshoot” that is the ARM. Don’t just assume that because rates are low, that they have to go up. We’ve had an economic upswing for the last few years, and rates still haven’t been raised yet. It’s more complicated than “The Fed raises the rates and my mortgage payment increases!”, discounting the fact that the Fed is already regretting that .25% interest rate increase.

People don’t understand how ARMs work. They believe that your mortgage rate can just go “anywhere” (usually up). But there’s a very hard limit on how high the rate can be and how much it can change at any given time. And this will be in your mortgage contract.

My very general recommendation to everyone is this: If you are going for a mortgage, ask to speak to a dedicated mortgage loan officer or specialist. Many banks have their general platform reps doing mortgages, but that’s not what you want. Mortgages are COMPLICATED. I personally try to avoid them like the plague. You want some whose specialty is mortgages and who doesn’t have so much of other people’s nonsense on his/her plate (following up on checks that need to be verified or making sure that someone’s debit card hold is removed) that your extremely important financial transaction gets lost in the pile. You are going to have complicated, detailed questions and you do not want us jack of all trades platform reps handling your mortgage (not to imply that non-MLO’s know nothing about mortgages, but it’s such a complex and important transaction that you really want a dedicated expert).

Find an MLO who can run in depth numbers for you and who has some control over what rates can be offered to you (a dedicated MLO can likely influence the rates to a minor degree; a regular platform rep really can’t). Make sure you include closing costs into those calculations. My opinion as far as the amortization schedule is that you should not reset it. But find a dedicated mortgage specialist that can really advise you. It sounds like the most pathetically obvious piece of advice, but people often come in and assume the first person they see is a walking mortgage encyclopedia. Those homebuyers/refinancers aren’t getting the guidance they need, which is why most people are still running into the comfortable arms of the 30 fixed rate mortgage.

Honestly, you should have to be licensed to sell mortgages. They are WAY more complicated than any of the products I deal with, and I’m a licensed banker selling insurance and annuities. And being NMLS certified isn’t the same as being “licensed”. Of course, this is me getting off topic and it’s a completely different conversation.

Sam, I’m just curious as to your thoughts on commercial mortgages (if you know anything about them). Do you feel the same way on a commercial ARM vs a long term fixed rate mortgage? My friends and I are looking to buy a mixed use property and we’re weighing our options right now.

Hey Sam – Great article, I have a challenging Question for you that I am sure you can answer.
My wife bought your book and is working towards getting a severance package. Meanwhile we have a rental property that we bought on cash (no financing). Now we are wondering should we refi this rental property before my wife’s W2 goes away? Even with mortgage the property should have positive cash flow. We dont need the money but with cost of captial being low, we are toying the idea to lever up and invest in other assets to get higher returns

Thanks for buying my book. I truly believe it will empower your wife to get more out of her separation agreement than if she did not read my book.

Your answer depends on your cash flow needs and existing cash balance. I am refinancing a 5/1 ARM jumbo from 2.625% down to 2.375% b/c it adjusts next year. I can get a CD for 2.4% right now, so therefore, my mortgage is essentially free if I have the same amount of cash invested in a CD.

You should definitely always refinance BEFORE losing your W2. But since you have no mortgage, then the other route is just a simple HELOC. Depends on what you need the cash for!

Thanks for the heads up. I had refinanced last year to 3.75% and didn’t track things (in particular since the Fed increased the prime lending rates. Finance creates weird situations that don’t always make sense doesn’t it?). Thanks to an all-expense paid trip to Afghanistan I have the ability to make no origination cost refinances on my home. I know you hate the 30 year loan but for me (planning to stay in place for another 2-3 decades and with relatively high expenses now (need to minimize the current payment)) means that I have no real problem locking in a 3.25% loan and then ramping up payments as children don’t require all-day daycare anymore (30k+ per year between 2 children).

BTW, small world. From what I saw in an earlier post you graduated from W&M in 99? Same year as my brother.

He is an IT Manager at Morgan Stanley (he was a CS major).
Hard to pass up the chance, I am only 2 years into owning this property and this would be my 3rd refi (I can do a 0 point, 0 fee, no appraisal refi) so I have been dutifully following the lower interest rate. 18 month repayment on this refi so it is a steal.

Does your recommendation for ARM apply to student loans as well, or just mortgages? I am halfway through my part time MBA and just started the loan consolidation shopping experience. Probably start with SoFi and see who can match them. 6~7% interest on 6+ separate deferred loans totaling $60k+ is killer…

Awesome teaching website and great motivation to the path of honourable financial independence. =)

Good question. I’m just familiar with the standard 10 and 20 year student loan repayment questions. Everything is an “ARM” in that sense. If you start making decent money – guess you are already making money doing the PT MBA, which is a great way to go – then I don’t you will end up taking 10+ years to pay of your student loans if you get motivated for financial independence! You’ll want to slay it ASAP.

Yes, most definitely! I heard the horror stories about fixed rates, but after your insight, adjustables don’t seem as much of a financial trap and can save more money in the short and long run especially since slaying it will be my #1 priority. SoFi has 5, 7, 10, 15, and 20 years now. More options are usually better. Yea, currently working FT in healthcare which is thankfully a secure industry.

Thanks for a great site! Looking for some advice on a refinance. I recently (2 months ago) purchased a property in the Bay Area with a 7/1 ARM mortgage. As a part of the purchase we converted our old primary residence to a rental property and the lender refused to count the rent towards my debt-to-income ratios. The ARM was the only way for us to qualify for the mortgage. Now just 2 months later I have found a lender that is willing to qualify me for a 30 year fixed mortgage.

The existing 7/1 ARM is at 3.375% and I can get the 30 year fixed at 3.75% with $4k closing costs. This is a jumbo loan slightly over $1M and my monthly cost goes up with $200.

Both me and my wife are risk averse and the 30 year fixed is very appealing. We are willing to pay for the peace of mind and we are planning to stay in this property long term (10+ years). Would this refinance be a really bad financial move?

My wife and I are under contract on our first home in the suburbs of NYC. Your articles have convinced me that an ARM is the way to go. I foresee us in our home for probably 7-10 years tops. Do you recommend that I go with a 5/1 or 7/1 ARM? If I understand correctly, I should try and refinance after the 5 years are up, for a *hopefully* better rate.

Both are fantastic rates! I’d go with 2.5% for 7 years since you plan to be there 7-10 years. When it’s time to reset or refinance, you will have probably paid down 10-15% of principal too, which will help with a new payment.

We will be closing on our second home in Mountain View next week and we have to make a decision on the rate TODAY! I found your page a little too late but hopefully you can get us some input.

For our first condo in Mountain View, we did the 5/1 ARM at 3% and it has adjusted to 3.5% for the next yr. So we are a big proponent of the ARMs. Now we are getting into a $980k mortgage with options of 3.5% for 30 yr fixed vs 2.625% for a 5/1 (+$1200 credits) or 7/1 ARM.

I would go with the 5/1 ARM. But what is the rate for the 7/1 ARM? How long do you plan to own/live in your house? I firmly believe rates will stay long for a long, long time. At least long enough to pay off our mortgages. Why pay 0.875% more?

Sam, I may be missing something basic, but how frequently should one refinance an ARM? My understanding is the overall term is always 30 years. Your experience in the past decade seems to imply that it’s optimal to get a 5/1 and then refinance after 5-6 years. But if you continue to repeat this process and if the rates continue to follow your prediction of staying low, you’ll also continue to reset the loan to another 30 years. At some point, does it make sense to just refinance to a 15 year conventional and prepare to ride it out? And does the process of refinancing eventually just feels too exhausting to be worth it?

Correct. Your mortgage will get recast back to a 30 year amortization period after every refinance. Therefore, it’s important to perpetually pay down principal as you go if you ever want to pay the mortgage off. There’s one camp where they say you should never pay off your mortgage due to the interest rate subsidies. I agree if you are in the highest tax brackets.

It most ARM cases over the past 15-20 years, ARMs would reset flat or maybe lower. But ARMs are tied to LIBOR, which is tied to the Fed Funds rate which finally got raised in Dec 2015. I don’t think the Fed will raise much at all for another 1-2 years. Too much uncertainty.

Ok, trying to figure this all out. Wife and I are in early 40s. We currently have 9.5 years left on a 2.75/10 yr FRM down from 3.375 on a 15 year FRM. Currently $1950 of the $2580 (P&I) payment is going to principal. The refi was at no cost because we are with Fremont Bank. Love them! Owe 254K and house appraised for 518K. Wife and I have W2 income of 205-210K. 280K in 401K/503b and we will both have pensions through CalStrs in about 18 years. We work 185 days a year. 2K in principal, 2K towards pensions and 1800 goes to 403b per month. So I guess we are technically saving about 5,800/month. That said, lifestyle is just as important at this stage as building wealth. We also pay the IRS about 7K at tax time with both of us claiming 0. No debt but no cash reserve either. That said, was not prepared to find a dream home scenario in Cali on a hilltop (full acre) over looking a body of water. New construction and will run about 950K. The builder doesn’t sell on contingency. Need a 5% deposit to move forward which we would need to be creative to come up with without selling existing home. Would love to keep existing in home a perfect world, but a full 950K loan seems rediculous with our income. At the very least, we would like to make the dream home work after selling our existing home. What’s the play here?

PS Besides the house on the hill, we would also like to either ultimately live in San Diego or figure out how to have a vacation home there.

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